The CFO’s Role in Financial Risk Management

For the ‘second year in a row’, the global demand for chief financial officers (CFOs) is breaking record levels. By the third quarter of 2024, 224 new CFOs had been announced among companies belonging to the top 12 global stock market indices. This puts the demand for CFOs ahead of chief executive officers (CEOs), who were historically the executive positions most often in need of filling.

Such a need for CFOs comes amid continuous international economic instability. Note that in 2024, worldwide inflation was estimated to exceed 4%.

Worryingly, financial analysts also warn of an impending recession. Recently, the BBC reported that the UK economy only grew by a minuscule 0.1% last year. In light of this, businesses are encouraged to invest in critical financial initiatives that CFOs are best suited to lead.

This includes financial risk management, which can ensure that businesses not only survive but thrive should further economic unrest come to pass.

Defining financial risk management

Financial risk management is a specialised concentration that falls under enterprise risk management (ERM). Considered a highly sensitive endeavour, it deals with identifying, handling, and responding to any potential finance-related issue that a business may face. Given that a level of risk is necessary in every business, financial risk management is also required to determine whether such endeavours are worth taking. However, since a business’s financial status and history are always in flux, it’s up to CFOs to ensure that the financial risk management they apply is nuanced and well-rounded.

Types of financial risks

Although the specifics behind whatever financial waterloo or pitfall a business may be facing, they typically fall under one of six general financial risks. Knowing about these types of risks is part of a CFO’s purview, as this information can help them finetune their subsequent actions.

Operational

As its name implies, this risk concerns any possible problems within a business’s day-to-day operations that inevitably impact financial outcomes. These can include challenges regarding manpower, physical infrastructures, and even digital work tools. For instance, if a business’s staff suddenly experiences a spike in sick leaves, this can hurt productivity and deadlines, which can pull down the bottom line. Often, CFOs and their department work closely with operational risk management (ORM) teams to best address this.

Credit

Credit risk is one that is more traditionally linked to dedicated financial institutions, as it refers to the risk that comes from borrowers not meeting their payments. That said, this can also be relevant to companies that allow customers to pay for services via a credit line. In most cases, businesses try to prevent this risk through failsafe, such as requesting collateral from borrowers. However, this may not be enough to totally prevent customers from missing payments, which can hurt a company if such instances happen too often.

Market

This risk focuses on the broader financial market, often related to macroeconomic factors. For example, forecasts in late 2023 stated that surging interest rates posed a significant danger for thousands of UK businesses. At one point, there were worries that up to 7,000 firms per quarter could shut down due to unsustainable borrowing costs. On the flip side, this same risk can also relate to lending and banking businesses that see a dip in borrowers due to similar macroeconomic influences.

Liquidity

Whereas credit risk concerns parties unable to pay businesses, liquidity risk is the inverse, affecting companies that cannot cover their expenses. Among small and medium enterprises, this risk is usually the most prevalent. This is because poor cash flow is a common struggle among these businesses, leading to up to 82% closing within just five years.

Foreign exchange

Also called currency risks, these occur when foreign currencies shift. Given that certain currencies, like the American dollar, have a foothold in most global markets, this risk can hurt even local businesses. Understandably, though, multinational companies, those that deal with imports and exports, and businesses with foreign holdings have the most to lose with regard to this risk.

Legal

When a business cannot keep up with its compliance and regulatory requirements, they have to deal with legal risks. Depending on a business’s industry, these risks can impair an organisation’s financial wellbeing through legal fees, settlements, and impacted revenue as a result of a negative image.

A CFO’s financial risk management responsibilities

As head of a business’s financial department, a CFO is in charge of recognising which risks their company may experience and how to minimise any potential fallout while also cementing a bounceback plan. This is often easier said than done, considering that it’s not uncommon for multiple risks to be present within a company’s ecosystem. Without somebody experienced, like a CFO, at the helm, it then becomes all too easy for these risks to overwhelm a company, even to the point of financial ruin. With that in mind, here are some practical ways that CFOs can implement effective financial risk management.

Optimisation of technology

Due to the increasingly complex demands and heavy expectations put upon them, the average time that a CFO stays in office is now just under five years. This is where regulatory reporting software comes in. A look at leading provider Wolters Kluwer’s OneSumX for Finance, Risk and Regulatory Reporting (FRR) solution suite highlights how this tool simplifies and streamlines key aspects of financial risk management. Namely, through such tech, companies can have their pertinent cross-departmental data culled and then studied before the software then paints an accrue risk profile.

This requires little to no manual intervention, so results are less likely to be tainted by human error or biases. It should also go without saying that this kind of software is able to work through vast volumes of data at a much faster pace than a human employee. This is yet another boon, as it means results can come in quicker without having to eat up so much of an employee’s own time and energy.

Additionally, data lineage is automatically preserved, thereby enhancing transparency and offering a paper trail for future scalability. Having this innovation within an organisation can help ease the burden on CFOs while also providing better overall team support, which is why it’s up to the executive to actively onboard such software.

Collaboration with legal entities

Every company, no matter their size or niche, is bound by legalities. As mentioned earlier, failure to adhere to these can easily result in financial hits. What’s worth noting, though, is that these can have some of the longest-lasting repercussions as it can also impact internal facets. This includes factors like team ethics and employee morale. Within the financial department, where teams may be forced to reckon with the resulting struggles coming from compliance, regulatory, or legal concerns, it can even snowball into higher rates of absenteeism, presenteeism, burnout, turnovers, and disengagement.

As the captain of this ship, CFOs are in charge of at least securing legal matters within the financial side. Since most legalese and rulings are subject to change in line with market or regulatory decisions, it’s important for businesses to work closely with legal experts. In bigger companies, this may be easier, given their in-house legal department. If need be, it may be in a CFOs best interest to extend their tech optimisation efforts towards their cooperating lawyers, too. For instance, it may help to introduce time-saving legal tools like Definely. The aforementioned company is a legal tech startup, and its software helps make drafting legal documents more efficient and accurate. For finance departments, this can help cut down the time in which they have to wait for regulatory papers and compliance reports to be created.

Establishment of a risk management strategy

Of course, at the end of the day, financial risk management only really benefits a company if it results in the creation of strategies that can mitigate any potential harm through proactive measures. As previously discussed in our guide to a CFO’s role in geopolitical risk strategies, proactivity is more efficient than mere reactivity. That being said, financial risk strategies need to account for every potential future problematic scenario, no matter how slim the chances of it actually happening are.

Crafting such strategies is no easy feat. It’s usually down to CFOs with enough training and experience to be able to create ones that are able to plan far enough ahead while still staying relevant to the company’s journey and sector. For instance, consider an ecommerce company that relies on organic posts, affiliate deals, and user-generated content for its marketing. Although it may not actually pay those who post about them online, it would do well to think ahead and account for any potential financial damage it may incur if one of the people who’ve posted about them is embroiled in a personal issue. Granted, the offending influencer is not a paid partner, nor is the issue in question related to the ecommerce brand. However, with respect to the power of public perception, having a strategy that accounts for this can help said brand save face, reputation, and revenue in a timely fashion.

The exact breakdown of such strategies can vary greatly, but generally, they should have risk predictions, cost-benefit analyses, forecasts of possible successes from well-calculated risks, and formal risk management policies. Developing these may take time and several iterations may have to be stress tested internally, but such efforts are invaluable, considering how much it can secure present and future financial outcomes.